THE recent activism of the chief regulator, the Securities and Exchange Commission of Pakistan, has brought under sharp focus the workings of some mutual funds. Most knowledgeable market players quietly suggest that at least four funds are being investigated for ‘insider trading’.

It is only fair if the regulator is digging deep into these funds, as they are the custodians of public money. Strict rules regarding monitoring have been put in place by the legislature and the funds themselves. Yet, it is still relatively easier for those with decision-making powers and the authority to allocate mutual fund assets to indulge in ‘front running’ and ‘insider trading,’ many analysts believe.

This happens in both emerging and developed markets. But suspicions aside, the funds said to be under investigation should be presumed innocent until proven guilty by the regulator.

Representatives of mutual funds should not hold the position of directorship on a company’s board — investment analyst Uzma Hayat

Over the years, the local mutual fund industry has shown a remarkable growth both in terms of assets as well as product offerings. Recent figures show that the industry holds Rs497bn under management. The bulk of this (Rs467bn) is in open-ended funds, followed by closed-end funds (Rs19bn) and pension funds (Rs11bn). All of that money is vested in the 214 funds that are being managed by 22 asset management companies.

In the open-end category, equity funds claim the biggest slice of the pie with Rs110bn under management. Money market funds follow with Rs108bn and income funds with Rs105bn. Among asset management companies, the top five include the National Investment

Trust (NIT), Al-Meezan Investment Management Limited, UBL Fund Managers, NBP Fullerton Asset Management Limited and MCB-Arif Habib Savings and Investments.

“The mutual fund industry is still a toddler as it comes up to just 5.86pc of aggregate bank deposits,” says Fayyaz Ahmed, who manages a medium-sized open-end fund. In comparison, the size of the Indian mutual fund industry is 12trn Indian rupees, while 50m people in the US — or one out of every three households — invest in mutual funds, he points out.

Yet, another fund manager observed that after getting burnt in multiple stock market crises over the years, small local investors now prefer mutual funds.

“Small investors are generally risk-averse, as price volatility in the market can unnerve even the most steadfast high net worth individuals. This is why they enter into mutual funds, which are managed by professional asset managers,” said the vice chairman of one of the top five open-end funds.

He also argued that it is much cheaper to hire an investment manager to manage a mutual fund for thousands of investors with a common goal than for each investor than to hire a stock broker and incur heavy transaction costs.

A week ago, the NIT announced its results for the half-year ending December 2014. Its assets under management stood at Rs96bn, up 17pc from Rs82bn at end-June. The net asset value of the flagship NI(U)T fund rose to Rs66.03, which worked its return out at 16.68pc for the period. The fund outperformed the KSE-100 index, which rose 8.32pc during that time. The fund’s assets also grew 21.6pc to reach Rs73bn by end-December, from Rs60bn on June 30.

Many people look up to the NIT to bail out the stock market during times of trouble. And after having invested in over 200 listed companies, the NIT does come to the market’s rescue in turbulent times.

Tariq Iqbal Khan, former managing director of NIT, says keeping mutual funds out of the boardroom would be against ‘corporate democracy’. Even in case of mutual funds, the consequential beneficiaries are the unit-holders

The benchmark index has dropped 9.6pc from its peak in February, mainly due to a sell-off by foreign investors to the tune of Rs11.6bn. While some institutions scrambled to book profit, local mutual funds bought a net Rs9.9bn (since December), absorbing a large portion of the foreign sales.

“Mutual funds and individuals, who were very active in building their exposure in equities thanks to falling interest rates, seem to be already invested now,” said a Topline Securities report last Thursday.

Besides equity funds, other asset classes such as fixed income funds, growth funds, money market funds, balanced funds, capital protected funds and Islamic funds have all met with varying degrees of success.

Although Islamic funds have come to occupy a prominent place, the general public’s lack of awareness and understanding about mutual funds and Shariah-compliant investments and their benefits has prevented the industry from reaching its true potential.

While the nature of the alleged ‘insider trading’ by a few mutual funds being investigated by the SECP is not known, the subject has generated a heated debate. “Representatives of mutual funds should not hold the position of directorship on a company’s board,” says investment analyst Uzma Hayat.

Other analysts concur, explaining that mutual funds are not themselves the biggest shareholders of the companies, but they represent their unit-holders. They believe that there could be conflicts of interest as directors representing mutual funds are armed with confidential information discussed at companies’ board meetings, unlike the funds’ unit-holders.

The matter assumes significance in the case of the country’s largest mutual fund — NIT — which commands directorship in scores of companies.

But Tariq Iqbal Khan, former managing director of NIT, disagrees. He contends that keeping mutual funds out of the boardroom would be against ‘corporate democracy’.

“Anyone who has sufficient votes to acquire a seat on a company’s board should have the right to enter the boardroom,” he says, adding that even in case of mutual funds, the consequential beneficiaries are the unit-holders.

Iqbal makes a pertinent point. And if mutual funds are to be denied directorship at companies, the law would have to be stretched to also push government nominees off the boards of directors, since the government is also the custodian of public money, he adds.

Published in Dawn, Economic & Business, March 23rd, 2015

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